Rate Hike In A Time Of Uncertainty
The central bank of Mexico (Banxico) in a statement released on November 17th stated that it increased its policy rate by 50bps to 5.25%, in line with the median of the Bloomberg survey. The move was seemingly slightly below market expectations as well as compared to many analyst forecasts of an increase of 75bps.
Banixco’s board stated that it believes uncertainty and volatility in the Mexican peso (MXN) and Mexican rates markets will continue. Given the opaqueness with respect to future economic policies in the US, which have not been defined by the upcoming administration.
The central bank also believes that potential increases in gasoline prices in 2017 will only be temporary. Noting the country’s current strong macroeconomic fundamentals was also taken into consideration. While the board noted that such fundamentals have improved recently given the fiscal consolidation, there could be further peso depreciation. This depreciation could very well materialize if US president-elect Donald J. Trump were to carry out policies that negatively impact Mexico’s economic outlook. Abandoning NAFTA, for example.
“We believe potential Mexican peso depreciation in the future could impact inflation expectations,” Benito Berber, senior Latin America strategist with Nomura Securities wrote in a note to clients on November 17th.
“In our view, Banxico has relinked its own future monetary policy to that of the Mexican peso. This could indicate that if peso depreciates further, Banxico is likely to increase the policy rate to prevent an increase of the market’s inflation expectations. Interestingly, we do not believe that Banxico signaled the start of a tightening cycle.”
Remarkably, Berber explains, Banxico’s communique on November 16th also included a line that it has used in the past with regard to the board’s intention to link future changes in the policy rate depending on what actions the US Fed takes.
“We find this interesting because thus far this year, Banxico has increased its policy rate by 200bps, while the US Fed has kept its policy rate unchanged,”
The combination of these moves has clearly widened the overnight interest rate differential. Nomura now believes Banxico could be indicating that the overnight interest rate spread with the US will either remain at almost 500bps, which is 100bps above the 10year average of 400bps, or possibly widen further. In sum, Banxico did not appear overly concerned about pass-through or the market’s inflation expectations.
While Banixco recognized that economic activity is slowing, it stated that it remained open to the possibility of further MXN volatility, which could prompt the board to increase policy rates further.
“Consequently, we lower our expectation for a policy rate increase at the 15 December meeting to +25bps from +75bps previously.”
This scenario is likely to materialize should the US Fed increases its policy rate by 25bps at its December 14th meeting, and also provided that Mr. Trump does not declare anything that could then negatively impact the peso before year-end, which in turn could lead to larger rate increases.
